The FTSE 100 treaded water on Tuesday as investors balanced rising geopolitical risk in the Strait of Hormuz against signs of weakening demand in the UK economy. The index barely moved, reflecting a market caught between two opposing forces: the threat of higher oil prices and the reality of sluggish growth.
What's happening in the Strait of Hormuz?
The Strait of Hormuz is a narrow waterway between Iran and Oman through which about 20% of the world's oil passes. Any disruption there can quickly push up global oil prices, feeding into higher fuel costs and broader inflation. Recent attacks on shipping in the area have revived fears of a supply crunch, similar to earlier episodes that sent crude surging. For context, past tensions in the region have led to sharp oil spikes, as seen when oil surged past $79 after a naval blockade was reinstated.
Berenberg, a German investment bank, warned that these attacks add upside risk to its inflation outlook. If oil prices rise significantly, it could push up costs for businesses and consumers, complicating the Bank of England's task of keeping inflation under control.
Why the Bank of England might hold back
Despite the inflation risk from higher oil, Berenberg expects the Bank of England to let its so-called 'insurance policy' of future rate hikes fade. That insurance policy refers to the market's expectation that the Bank could raise interest rates again if inflation proves stubborn. But Berenberg argues the UK economy looks more like it's running short on demand than running too hot. Weak consumer spending, sluggish business investment, and a cooling labour market all point to an economy that needs support, not tighter policy.
If the Bank of England signals it is done raising rates, that would be a positive for UK stocks and bonds. Lower rates reduce borrowing costs for companies and make future profits more valuable. But it also means the Bank is willing to tolerate slightly higher inflation, at least for now, if it comes from temporary supply shocks like oil disruptions.
What it means for investors
For everyday investors, the key takeaway is that the FTSE 100 is stuck in a tug-of-war. On one side, energy stocks and commodity-linked companies could benefit from higher oil prices if the Strait of Hormuz tensions escalate. On the other side, the broader market is held back by weak demand and the risk that higher oil costs squeeze consumer spending.
Berenberg's view suggests that the Bank of England is unlikely to panic over a temporary oil spike. That should provide some comfort to investors worried about a return to aggressive rate hikes. However, if the Strait of Hormuz disruptions become prolonged, the calculus could change. Past episodes, such as when stocks dipped after a proposed 20% toll on Hormuz cargo, show how quickly sentiment can shift.
Investors should also watch how other central banks respond. If the European Central Bank or the Federal Reserve take a similar dovish stance, it could support global equity markets. But if oil prices keep climbing, the inflation risk may eventually force their hand.
The broader picture
The FTSE 100's flat performance is a reminder that markets are pricing in a delicate balance. The index includes many multinational companies that earn revenue in dollars, so a weaker pound can boost their value. But the domestic economy remains fragile, and any shock to oil prices could tip the balance.
Berenberg's analysis highlights a key insight: not all inflation is created equal. Supply-driven inflation from oil disruptions is different from demand-driven inflation that comes from a booming economy. Central banks have less control over supply shocks, so they may choose to look through them rather than raise rates and risk damaging growth.
For now, the market seems to agree. The FTSE 100 is treading water, waiting for clearer signals on both oil and interest rates. Investors should keep an eye on the Strait of Hormuz, but also on UK economic data that will tell them whether demand is truly fading.
